The biggest problem for the digital currency is still politics, not concept.

26.10.2013

After a torrent of bad news, the digital currency Bitcoin has survived to fight another day. According to one economist, the next battle is likely to be with the government. Bitcoin is an open-source, decentralised, digital currency, whose production is designed to simulate the mining of a commodity, like gold. Mining bitcoins is, obviously, a bit different: Bitcoin clients, which anyone can run, race to solve cryptographic puzzles.

Those that reach certain milestones first receive the new bitcoins with ever decreasing frequency, in order to keep an influx of users from changing the number of bitcoins in existence too quickly (and ultimately to stop production of bitcoins altogether).

The new bitcoins are then added to the network, and validated by all other Bitcoin users. The currency was around as a tech curio for years, the enigmatic original designer "Satoshi Nakamoto" (no one knows who this is), but when its price increased 200-fold – well, people noticed. But many forecast that Bitcoin was doomed to failure. Bitcoin's brightest day so far may well have been October 1. That day, years after Bitcoin's inaugural buzz, Reuters reported venture capitalists "show[ed] no sign of shying away from investing in start-ups related to Bitcoin".

Was stability finally looming for the tumultuous currency, which had bounced from less than $US1 per bitcoin in 2011 to $US266 this year? Advertisement Not quite. The next day, the US Department of Justice arrested Ross Ulbricht and shut down Silk Road, the anomalous black market accessible only through the Deep Web. In doing so, law enforcement performed the largest Bitcoin seizure in history: 26,000 bitcoins worth approximately $US3.6 million from Silk Road users. Their eyes are still set on a bigger prize: the nearly 600,000 bitcoins Ulbricht allegedly collected as commission for running the bazaar. Because the government has been unable to crack Ulbricht's private key, a necessary step in accessing his digital wallet, acquisition of that jackpot has proved more difficult. Those 600,000 would be worth, today, about $US85 million.

They also account for about 5 per cent of all Bitcoins in existence today. Silk Road was one of the most critical support beams for Bitcoin. In March, 7000 of 10,000 items on Silk Road were drugs. After the news, the value of a bitcoin plummeted from $US145 to less than $US110. And the claims of the currency's demise reignited. But the currency has stood strong, and jumped back to more than $US130 the day after Ulbricht's arrest.

As of this week, it's back at about $US144. The market's resilience bolstered an optimistic, underdog outlook about the news, which viewed the arrest as a necessary step toward legitimacy. After all, Silk Road's reputation for illegal activity – from drugs to guns – made it an easy target for Bitcoin critics. (Silk Road's seizure will not be the last, either: the success of both Bitcoin and Silk Road has already inspired competitors.) So what about our economist's warning about trouble with governments? Simon Johnson, a professor of entrepreneurship at MIT's Sloan School of Management, expects "big political backlash". The seemingly inevitable collision stems from the novelty of a currency over which no government has tight control. While Bitcoin has survived the exorcism of what was arguably its largest devil – that is to say, its largest political liability – others remain, which means if the US Department of Justice does decide to throw another punch, it won't have a hard time finding a weak spot. One venture capital firm says online gambling accounts for almost half of all Bitcoin transactions.

Also vulnerable are the exchanges that manage Bitcoin transactions and currency conversions. These exchanges have repeatedly walked into finance-law hornets' nests. Lobbyists will almost certainly play a role: entire industries are threatened by Bitcoin. At a modest scale, Bitcoin provides an evolutionary step away from credit cards, which charge fees for each transfer (either to the consumer and/or the seller). Even services such as PayPal remain dependent on the credit card industry, while Bitcoin transactions never go through a credit card agency and incur no (or small) fees. If it reached a larger scale, Bitcoin could rival banks, which also reap huge profits from money transfers and can wield enormous lobbying campaigns. In the long term, were Bitcoin to become a viable rival currency, it would have severe consequences for the basic monetary policies of Western economies – and the finance industry they empower. And that's all without any new law specifically targeted at Bitcoin.

Bitcoin stakeholders have been meeting with regulators to try to figure out exactly what existing laws actually apply to this new currency. Its use in a Ponzi scheme forced the Securities and Exchange Commission's hand earlier this year. The agency argued that bitcoins were money, and in August, a court agreed. It means Bitcoin is one important step toward being considered a viable currency. It also means the nascent Bitcoin industry must comply with a host of laws that not long ago it had a reputation for flouting. While regulators are likely to promulgate new rules without much fanfare, some legislators have also drawn lines in the sand. Bitcoin supporters should keep their eyes on at least one politician, US Senator Chuck Schumer, who called Bitcoin a form of money laundering back in 2011. Bitcoin may be un- or underarmed in a political fight: without a centralised power source, it's unlikely that Bitcoin will be able to marshal the political might of the industries it is disrupting.